ECONOMYNEXT – Sri Lanka’s latest tax upheaval from the 2022 budget which has repeated a ‘super gains tax’ to penalize large firms and brought back a cascading turnover tax instead has left many tax payers guessing over their application.

Sri Lanka had to impose higher taxes to cover expenses after a steep cut in value added tax in 2019 without a sitting parliament de-stabilized state finances after the state was expanded from 17 percent of GDP to over 20 percent under an unusually statist ‘revenue based fiscal consolidation’ strategy.

Exporters are likely to face a non-recoverable turnover tax from the social security tax, unlike the earlier higher rate VAT which does not hurt external competitiveness. Price controlled industries like pharmaceuticals would also be squeezed.

Super gains tax ‘normalized

In the 2022 budget a ‘super gains tax’ where large companies are targeted with a windfall style tax was repeated retrospectively, normalizing an additional ‘regime uncertainty’ to the country’s policy framework which began in 2015, critics say.

Private firms and chambers had sought clarity from authority while some industry groups were engaged in intense lobbying to minimize the effects of some of the new taxes.

The 2022 super gains tax is to charge an additional 25 percent from large companies that earn more than 2.0 billion rupees in profits, where returns have to be filed by end November.

“The issues that are not clear at the moment is whether the tax will be applicable across the board for all companies irrespective of their tax rates,” Duminda Hulangamuwa Senior Partner and Head of Tax of Ernst and Young in Sri Lanka told representatives of the top German brands in Sri Lanka.

“There are companies with 14 percent (corporate income) tax rates, there are companies with 15 percent, there are companies with 18 percent and 24 percent.

“My presumption is that it will go across the board in order to get the 100 billion rupee revenue to all industries, unless there is a development to that.”

There are also companies which are exempt from taxes.

About 80 billion rupees extra had been spent on the Coronavirus vaccines which had benefitted everyone. However questions are being asked by Chambers and others why only a selected few are being made to pay and not everyone.

“That is a call the government has to make. I am ok with either, but that is what people are saying,” Hulangamuwa explained.

There was also no information if marginal relief would be given to companies in the borderline.

“For example someone at 2.0 billion and one would pay, and a person at 1999 would not pay,” Hulangamuwa said.

“So someone at 1999 would get away and someone at 2001 would pay. There is no marginal relief to a person becoming short of just one rupee.”

In larger business groups, companies get dividends. The dividends are taxed by the declaring company already. The profits are taxed and the dividends are taxed at 14 percent.

If the recipient company goes over 2.0 billion taxes will have to be paid again.

“I do not think those are issues that have been addressed yet,” Hulangamuwa said. “I think these are issues that have to be addressed by the government when enacting the law into implementation.

“Now the question is who wants to be in the billion rupee club?”

The Rule of Law

Companies who had earned two billion had already used them for re-investment for expansion based on existing law. Some have also paid dividends and bonuses to workers.

“So they do not have cash though the profits are there to pay the tax. So these are the questions that are coming up. There are no answers to be given at the moment. Some are being taken up by the Chambers etc, but the final solution I do not have as to how and what base the tax will be levied on.”

The lack stable laws bring in what economists call ‘regime uncertainty‘, undermining rule of law, which analysts have said is one of the three biggest drawbacks the country faces along with monetary instability and nationalism.

“Nothing distinguishes more clearly a free country from a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law,” explains economist Friedrich von Hayek, in his work The Road to Serfdom.

“Stripped of technicalities this means that government in all its actions is bound by rules fixed and announced beforehand – rules that make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.

“Thus, within the known rules of the game, the individual is free to pursue his personal ends, certain that the powers of government will not be used deliberately to frustrate his efforts.”

“Hence the familiar fact that the more the state ‘plans’, the more difficult planning becomes for the individual.”

The super gains tax was introduced by the ousted ‘Yahapalana administration’ which pushed up state spending through a 100 day program and it has now opened a pandora’s box of uncertainty for large companies. It was then promised to be one time.

An extra 3 percent tax was charged on banks calling it the financial VAT replacing a removed 3 percent Nation Building Tax.

“So they pay the NPB back as a VAT on financial services.”

Banks are likely to pay around 70 percent in taxes for the last financial year.

Changes to the VAT was only in respect to donations made to government.

In most European countries VAT was close to 20 percent and in Sri Lanka it has been brought down to 8 percent from an earlier 15 percent as part of the sudden tax changes in 2019.

However VAT is neutral for exporters and does not hurt export the global competitiveness of export industries or services.

Cascading NBT returns

In the budget for 2022 another new tax had been brought calling it the ‘social security contribution’ at 2.5 percent.

“This is similar to the Nation Building Tax that was abolished last year. It was a tax on turnover, and this will also be a tax on turnover, except that the rate is half a percent more.

He said clarity was being sought on the tax base and on exemptions.

“When a tax is introduced we find a lot of people lobbying for their industry,” he said. “It will directly after the bottom line. You do not keep 2.5 percent on bottom-line.

“The retailers, the distributors, low margin companies, bunkering and price controlled industries like pharmaceuticals they are unable to increase their prices because of the 2.5 percent.

“I believe the government will give relief to the industries that are at a low margin level.”

Analysts say cascading taxes will generally result in higher prices.

“The next of course is exporters,” he said. “They are screaming saying that 2.5 percent under current circumstance where margins are challenging, markets are challenging that they cannot afford to pay the 2.5 percent.

“So, all these matters had been discussed with relevant government officers – the Treasury especially. And I believe there will be some relief and these matters will be addressed as we go along.” (Colombo/Nov28/2021)